Bonds benefitted as many of the world’s financial markets experienced their worst start to a new year ever. Equity markets were led lower by the Chinese Shanghai index which fell more than 22%. North American equity market moves were more muted, but the U.S. S&P 500 still lost more than 5% and the S&P/TSX declined 1.4%. Commodities too were weak, with oil dropping more than 9% in the month and copper losing over 3% in value. As large as these changes seem, they obscure the actual volatility that occurred in the month. For example, the S&P 500 had fallen 13% and oil plunged 29% in the first three weeks of the month before strong rallies occurred that erased most of the losses. Interestingly, the rebounds in various markets occurred almost simultaneously, beginning on January 20th, which can be observed in the chart below. The widespread losses in various asset classes prompted a flight-to-safety bid for sovereign government bonds and a risk-off sentiment toward riskier assets, including corporate bonds. The FTSE TMX Canada Universe Bond index returned 0.39% in the month.

Volatility - January 2016

The lack of a clear catalyst to January’s turbulence brings to mind U.S. President Roosevelt’s comment at his 1932 inauguration: “The only thing we have to fear is fear itself.” Some market analysts have suggested equity markets were overvalued by share buybacks that were unsustainable without stronger earnings growth. Others point to concerns about the pace of Chinese growth which were heightened by the lack of reliable economic data in that country, a 2% devaluation early in the month, and the need to use an immature stock market index as an economic proxy. Another possible contributor to the remarkable volatility was the continued near-zero interest rate policies of most central banks that encourage mispricing of risk. In addition, the sharp decline in oil prices seemed simply another example of the volatile nature of commodities that invariably overshoot fundamental value both to the upside and the downside.

Canadian economic data received during the month was mixed. On the positive side, retail sales in the most recent month (November) were much stronger than expected. Manufacturing sales were also ahead of forecasts, with good growth in new orders pointing toward strength in future production. In addition, the trade deficit was smaller than expectations as exports increased for the first time in four months. Canadian GDP grew 0.3% in November, but that pace was viewed as unsustainable by many economists. Less positively, unemployment rose to 7.1% from 7.0% and job creation was centred in poorer paying part time positions. Canadian inflation increased by less than expected but still increased to 1.6% from 1.4%. The Bank of Canada left its trend-setting interest rates unchanged at its January meeting. The Bank indicated that it was waiting for details of the promised fiscal stimulus package from the new federal government before deciding on the need for additional monetary stimulus. As well, it appeared that the Bank did not want to cause further declines in the exchange rate.

U.S. economic data was also mixed in January but, on balance, was somewhat disappointing. Unemployment held steady at 5.0%, as very strong job creation was absorbed in a higher participation rate. The good labour market translated into improved consumer confidence. Unfortunately, higher confidence did not lead to stronger retail sales, as consumers preferred to pay off more debt and increase their savings. Industrial production was weaker than expected, primarily due to weaker utilities (weather) and mining (oil & gas), but the manufacturing sector continued to struggle with the high value of the U.S. dollar and weak global demand. As well, the first estimate of fourth quarter growth in U.S. GDP came in at a disappointing 0.7% pace. The U.S. Federal Reserve left interest rates unchanged, but it acknowledged that economic growth had been slower than expected since its December meeting at which it increased interest rates. The Fed’s rather dovish statement following its January meeting prompted many observers to revise down their expectations for future rate increases and that helped lift U.S. bond prices.

1 2 3